Wednesday, March 20, 2013

No bailout without bail-in for Cyprus?

Yesterday evening, the Cypriot parliament brought the euro crisis back to the centre stage. The “no” vote on the bailout plan could have marked a new and uncertain stage in the entire euro crisis.

In the end, no single Cypriot parliamentarian was in favour of the bailout package, decided last week by the Eurogroup and the Cypriot government. In last night’s vote, 36 members of parliament voted against the proposal and the other 19 members abstained. The most controversial part of the bailout is the levy on bank deposits. Even a slight revision of the original plan, namely an exemption of deposits below €20,000 did not change parliamentarians’ minds. With the “no” of the Cypriot parliament, there is no bailout for the time being.

So what is next? The ECB already stopped playing hardball and announced last night that it would provide liquidity to Cyprus “within existing rules”. This can buy time but will not solve the Cypriot problems. With the genie of the deposit tax out of the bottle, time is of the essence. Re-opening the banks without a solution would probably lead to a massive capital flight.

In fact, Cyprus has two main ways out of the current deadlock: i) a renegotiation of the current bailout terms with the Eurogroup; or ii) finding other financial sources to fund the required €5.8bn in the bailout.

At the current juncture, a softening of the bailout terms looks unlikely. The Eurogroup will want to keep maximum pressure on Cyprus, stressing that the ball is with Cyprus and that the Eurogroup’s offer for a bailout is still valid. However, let’s not forget that the Eurogroup statement from last week did not quantify any amount the deposit levy should yield but was kept rather general, saying that “the Eurogroup further welcomes the Cypriot authorities' commitment to take further measures mobilising internal resources, in order to limit the size of the financial assistance linked to the adjustment programme. These measures include the introduction of an upfront one-off stability levy applicable to resident and non-resident depositors. Further measures concern the increase of the withholding tax on capital income, a restructuring and recapitalisation of banks, an increase of the statutory corporate income tax rate and a bail-in of junior bondholders.” In European language this could eventually offer some room for manoeuvre.

Finding other financial sources seems to be the last straw in the eyes of the Cypriot government. There were several reports that Cyprus was trying to get financial support from Russia. Other options could be the increase of other taxes or privatisations. A combination of several options has recently been proposed by Russian energy giant Gazprom which according to media reports has offered Cyprus a plan in which the company will undertake the restructuring of the country’s banks in exchange for exploration rights for natural gas in Cyprus. Clearly an option with far-reaching geopolitical consequences.

However, even if Cyprus were to find other ways to finance its own contribution to the bailout package, it is doubtful whether the Eurogroup would go along with it. Last night, German finance minister Schäuble reiterated on German television that according to him the business model of the Cypriot economy had failed and needed a make-over.

Another option for Cyprus could be to come up with an own alternative for a private sector involvement, by for example exempting all insured depositors from the tax and replacing uninsured deposits above €100,000 with so-called bank certificates of deposit, linked to future natural gas revenues.

Earlier in the euro crisis, Greece called Angela Merkel’s bluff and the threat of being expelled from the Eurozone. It looks as if Greece’s neighbours now think that they can also call the Eurogroup’s bluff. They might be wrong. Even if the Eurozone eventually will probably offer some room for manoeuvre, it is hard to see that the German government will give up the demand for private sector involvement and far-reaching reforms of the Cypriot economy.